Take cover from retirement risks?
It's best to err on the side of caution when you start feathering your nest egg
- By Lorna Tan, Senior Correspondent (The Sunday Times / Jun 13, 2010)
Japan, the world's most aged society, is preparing for a surge in retirees in 2012, when its first batch of official baby boomers turns 65.
Singapore, like many other advanced nations, is facing similar challenges.
The Republic is expected to approach 'aged society' status, according to a United Nations benchmark, at the end of this decade. Singapore is currently considered an 'ageing' society as more than 7 per cent of its population are 65 or older.
A society becomes 'aged', according to the UN, when the number of people 65 and over tops 14 per cent. Japan has already been accorded 'super aged' status, with over 20 per cent who are 65 and over.
Nearly 23 per cent of Japan's 126 million people will reportedly be 65 and older this year, the highest proportion in the world.
In a recent interview, Mr Satoshi Nojiri, US fund manager Fidelity International's director of Fidelity Investor Education Institute in Japan, said Singapore will soon encounter the same retirement issues facing Japan now.
For instance, Fidelity's latest survey of 10,000 Japan workers indicated that the majority recognised that health-care costs are the largest expense in retirement. About 44 per cent of respondents had not started saving for
retirement and those who had, had saved only one-sixth of the retirement income needed.
Mr Roy Varghese, foundation adviser and director at Ipac Financial Planning Singapore, said that unless one is flush with cash, one should delay retirement for as long as possible.
Retirees should also be mentally prepared to return to the workforce if the need arises and to consider downgrading or selling their homes to raise funds.
The Sunday Times highlights some retirement risks worth considering.
Longevity risks
With advances in medicine and technology, there is a greater probability of outliving your savings and assets.
'So don't underestimate your life expectancy,' cautioned Mr Nojiri.
This was the main reason that the Singapore Government initiated the national annuity scheme Central Provident Fund (CPF) Life, which provides a regular payout for as long as you live. The payouts are funded by the CPF Minimum Sum (MS), which will be raised to $123,000 next month.
But other sources of retirement income are necessary to ensure a comfortable retirement.
Health-care costs risk
This is expected to be the biggest cost in retirement. Studies have shown that for a person above 65, medical expenses are substantially higher in his last year of life.
However, most healthy people underestimate health-care or nursing care costs, pointed out Mr Nojiri.
One solution is to pass on some of the risk to insurers. It is worth your while to shop for a suitable hospitalisation and surgical insurance plan. It is a no-brainer to opt for one that provides a lifetime cover, guarantees yearly renewability and comes with an 'as-charged' feature that does away with benefit
limits.
Premature retirement risk
Leaving the workforce before you have accumulated enough for your nest egg is another risk, said Mr Varghese.
You would not want to be caught in a situation where you realise, too late, that there is a substantial gap between how much you have saved and how much you need during retirement.
'Some people quit their careers too early, thinking they have saved enough for their 30-year 'vacation'. For some, it may be impractical to consider re-entering the workforce after a five- to 10-year break when reality sets in,'
said Mr Varghese.
If you plan to retire at 60 - after leading an economically active life for nearly four decades - and expect to live till 90, that is an incredibly long period without a regular pay cheque. To sustain a meaningful retirement, it is
prudent to calculate your retirement income seriously instead of relying on rough estimates.
When arriving at a suitable target retirement sum to be accumulated before quitting full-time work, a fixed payout rule may be helpful. So if the annual fixed payout rate is 4 per cent, it means that you expect a slow drawdown of a lump sum based on 4 per cent of your investments.
Let's assume a couple require a monthly retirement income of $3,000 from age 60, which means an annual lump sum of $36,000. To achieve this, the target retirement fund is worked out to be $900,000 which is assumed to be eventually used up or drawn down by the couple over the next 30 years. This is assuming that the sum is invested in a low risk portfolio with an expected annual return of 4 per cent which takes into account an inflation rate of 3 per cent.
Ipac worked out that if the couple require higher monthly retirement incomes of $5,000 and $10,000, the target retirement funds at 60 would be $1.5 million and $2.4 million, respectively.
Withdrawal risk
Even the best laid plans may be derailed owing to bad planning or unforeseen circumstances. One example is excessive spending in the early years of retirement.
Mr Varghese noted, for instance, that some folks may be tempted to go on a round-the-world trip or splurge on an expensive car shortly after retirement. This is not prudent as the indulgence may result in reducing the number of years that your retirement fund can last. When this happens, you may be forced to sell the family home to make up the shortfall.
Let's say a couple expect that they require a monthly income of $3,000 to meet their retirement needs but they spend $5,000 in the first year instead, with subsequent increases of 3 per cent a year.
In this scenario, they decided to cut spending only from the sixth year. Mr Varghese worked out that because of the overspending in the initial five years, their total retirement fund of $900,000 could last only till 84 years of age instead of 90. In other words, they face the possibility of struggling for cash for six years.
'Be disciplined in the first two years of retirement in terms of discretionary spending. If the desired lifestyle expenses were underestimated, part-time work must be considered to beef up the nest egg,' he advised.
Asset allocation risk
For all investors, diversification is key as it is unwise to put all your eggs in one basket. But this factor is even more critical for older investors and retirees as they do not have the advantage of a long-term investment horizon.
Mr Albert Lam, investment director at IPP Financial Advisers, recalled the experience of a distant relative who had retired but had made the mistake of investing only in blue chips, believing that nothing could go wrong.
'In his first year of buying 'safe' blue- chips, he was up $1.5 million, but in the second and third year, he lost $700,000 and $1.5 million, respectively. He has had to downgrade from his comfortable retirement home and find part-time work so as to provide for his spouse and himself.'
Mr Lam suggested that a more suitable portfolio for a retiree would be one comprising mainly fixed income assets. This will ensure a lower range of volatility and at the same time provide some returns to offset the inflation effect.
Mr Varghese recommended the following asset allocation: cash (25 per cent), global fixed income (40 per cent), global real estate investment trusts (10 per cent) and global equities (25 per cent).
He added that it is prudent for retirees above 80 to have their retirement funds mostly in cash so as to mitigate market risks.
Wherever possible, try to balance withdrawal with the investment performance of the retirement portfolio so as to ensure that the funds last longer, said Mr Nojiri. This is because the returns of the portfolio are not guaranteed and are subject to market risks and economic factors.
Inflation risk
The rate of inflation is an important factor when planning your retirement funds as it will erode the value of your funds over time.
'You may not realise how big the impact of inflation is in 10 years even if it is a small increase each year,' said Mr Nojiri.
For instance, based on an average inflation rate of 3 per cent, $1,000 today will be worth only $642 - in terms of today's spending power - in 15 years' time.
This year, Singapore's inflation is projected to come in at 2.8 per cent.
To illustrate the impact of inflation, let's use the above example of the 60-year- old couple who require a monthly retirement income of $3,000 and have accumulated $900,000 to last them 30 years.
If we assume three five-year periods during the 30-year timeframe, where the future inflation rate is a higher 5 per cent a year, the couple's expenditure will also rise by 5 per cent a year, as they will require more money owing to inflation.
Mr Varghese worked out that the impact of higher inflation to the portfolio will be a reduction of the drawdown period to age 84 instead of the original 90.
'Do not underestimate the possibility of higher than normal inflation rates in old age,' he warned.
Liability risk
Currently, most banks here do not extend housing loan repayments beyond the age of 70. However, there are other liabilities that you may be saddled with in your golden years, such as personal loans, car loans and insurance premiums.
'This could put a heavy burden on you if you have no income coming in,' said Mr Lam.
As such, he advises that should such loans be taken, the interest repayments should be offset by income sources from employment, businesses or investments.
Extended bear markets
An example of an external factor that will have an impact on your retirement portfolio is an extended bear market where prices of equities fall over months or years. If you are caught in such a scenario and are over-invested in equities, you might be forced to sell out at the worst time - when prices are at an all-time low.
Instead of timing the market, Mr Varghese's advice is to stay invested after a market decline to benefit from the subsequent recovery.